Defined Contribution Health Plans

May 17, 2000

Employers are shifting from defined benefit pension plans that guarantee a set amount of retirement benefits to employees to defined contribution pension plans that allow workers to invest for retirement. Similarly, employers are shifting to defined contribution health plans, according to the firm of Booz-Allen & Hamilton. The switch will give workers more choice in selecting their health benefits.

And within the next 15-20 years if not sooner, the new plans will create a consumer-driven health care system that will capitalize on the use of the Internet. The shift could accelerate due to a recession, if costs increase for health benefits at a faster rate and due to changes in federal laws governing health plans.

Defined contribution health benefits work like this:

The employer makes a certain set amount of money available to the employee for health-related benefits.

The employee then determines how best to allocate that contribution to cover his or her particular health care needs.

The employee compares plans based on their features, risks and pricing to select a plan.

Married employees might combine the defined contribution benefits of their spouse and select a joint plan, freeing up some money for other benefits such as a contribution to medical savings accounts. The availability and ease of use of medical savings accounts would allow price savvy consumers to better utilize these benefits without encouraging overuse of the health system.

In marketing and administrative costs alone, the new plans will free approximately $18 billion currently spent by employers. Employers now pay all of these costs for their employees as a group. Defined contribution plans reduce these costs by allowing employees as consumers to individually search for their own plan to fit their specific needs.